This paper analyzes optimal monetary policy under precommitment in a state-dependent pricing (SDP) environment. Under SDP, monopolistically competitive firms are allowed to endogenously change the timing of price adjustments. I show that this endogenous timing of price adjustment alters the tradeoff and the cost of inflation variation faced by the monetary authority in comparison to the standard time-dependent pricing (TDP) assumption. In particular, it is desirable to let inflation vary more under SDP. Despite the change in the tradeoff, however, the optimal response under SDP to either a productivity or a government purchase shock under the timeless perspective (long-run) policy can still be characterized as an approximate price stability rule. In addition to a standard first-order approximation to the equilibrium solution, this paper also computes a second-order solution where the effect of state-dependence can play a central role. The policy response under SDP exhibits some degree of nonlinearity, especially in the presence of larger shocks and when the state of the economy is farther away from the steady state. Finally, this paper also studies the optimal policy start-up problem related to the cost of adopting the timeless perspective policy instead of the true Ramsey policy. The SDP assumption leads to different start-up dynamics compared to the dynamics under the TDP assumption in several interesting ways. In particular, the change in the policy tradeoff gives rise to much higher start-up inflation under SDP.
Sticky prices, endogenous export participation, and real exchange rate fluctuations (September 2009) PDF
Abstract:
This paper develops a two-country DSGE model where firms optimally decide whether to engage in the export market. The heterogeneous firms face infrequent opportunities to adjust prices and are subject to fixed costs of exporting drawn independently from a time-invariant distribution. This endogenous firms exporting decision provides a new additional channel for the transmission of monetary shocks. The model is able to generate several important features of the firm-level data on international trades as documented by Bernard and Jensen (2005). A novel feature of the model is that consistent with the data evidence, some low-productivity firms may still find it profitable to export even though they are less likely to export on average. The model predicts that under financial autarky and balanced trade and when the economy is dominated by monetary shocks, endogenous export participation magnifies the real exchange rate volatility when producer-currency pricing is assumed. Under local-currency pricing, the volatility is dampened. The contrasting response of the changes in relative availability of goods varieties across countries (extensive margin) following monetary shocks provides the exhibited result. Variations in the relative set of available varieties serve to modify the extent of expenditure switching, which importantly affect the real exchange rate fluctuations.
Closed-form estimates of the New Keynesian Phillips Curve with time-varying trend inflation (with Michelle Barnes, Fabià Gumbau-Brisa, and Giovanni Olivei) - version: December 29 2009 (also available as Federal Reserve Bank of Boston Working Paper 09-15) PDF
Abstract:
We compare estimates of the New Keynesian Phillips Curve (NKPC) when the curve is specified in two different ways. In the standard difference equation (DE) form, current inflation is a function of past inflation, expected future inflation, and real marginal costs. The alternative closed form (CF) specification explicitly solves the DE form to express inflation as a function of past inflation and a present-discounted value of current and expected future marginal costs. The CF specification places model-consistent constraints on expected future inflation that are not imposed in the DE form. In a Monte Carlo exercise, we show that estimating the CF version of the NKPC gives estimates that are much more efficient than the estimates obtained from the DE specification. We then compare DE and CF estimates of the NKPC with time-varying trend inflation on actual data. The data and estimation methodology are the same as in Cogley and Sbordone (2008). We show that DE and CF estimates differ substantially and have very different implications for inflation dynamics. As in Cogley and Sbordone, it is possible to estimate DE specifications of the NKPC where lagged inflation plays no role once trend inflation is taken into account. The CF estimates of the NKPC, however, typically imply as large a role for lagged inflation as for expected future inflation. These estimates thus suggest that trend inflation is not in itself sufficient to explain the persistent dynamics of inflation.
Work in progress:
Straightforward approximate stochastic equilibria for nonlinear Rational Expectations models (with Michael K. Johnston and Robert G. King; May 2009) - currentlyunder revision
Abstract:
This paper presents a new approach in computing approximate stochastic equilibria for nonlinear rational expectations models. Unlike the existing perturbation method in the literature, we deduce restrictions directly on the stochastic differentials of the model equations. Our innovation is based on the ideas that a rational expectations solution typically makes all variables depend on an infinite history of shocks and this history is naturally suited to perturbation. The approach has several highly desirable features: (i) solutions are state-space linear, which makes forecasting and computation of impulse responses straightforward; (ii) the state-space form is achieved without any additional modification such as pruning; (iii) it extends existing methods to accommodate state-dependent responses and endogenous time-varying uncertainty; (iv) the linear representation of a nonlinear approximation makes solutions obtainable quickly and easily; (v) it provides a simple alternative to the proofs on approximations in various studies and simultaneously resolves some of the puzzling aspects of perturbation approximations discussed in the literature; and (vi) the method applies to any order of approximation.
Recursive optimal policy design: nonlinear decision rules and welfare (with Michael K. Johnston and Robert G. King; September 2008) -currently under revision
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